Is the Southern Company dividend safe?
Southern Company is one of the first stocks I bought in 2003 when I started building my dividend stock portfolio.
On the other hand, I have not added to my position in Southern stock since early 2018.
Furthermore, the company has encountered operating challenges in the last few years. And I am a little concerned about the safety of the substantial dividend that Southern stock pays me as an investor.
SOUTHERN COMPANY DIVIDEND DEEP DIVE
So let’s see if my concerns are warranted. Maybe the dividend is safe? Let’s find out and run Southern stock and the Southern Company dividend through a Dividend Deep Dive.
But before we get started, please note that Southern stock trades on the New York Stock Exchange under the ticker symbol – SO.
SOUTHERN COMPANY BACKGROUND
Southern provides energy to customers in the United States through:
- Electric operating companies in 3 states
- Natural gas distribution companies in 4 states
- A generation company serving wholesale customers in all states across American
Furthermore, Southern Company is a nationally recognized provider of energy solutions, as well as fiber optics and wireless communications. Source: Southern Company – About Us
The company’s service territories are focused in the Southeastern and Mid South United States.
Perhaps you are a customer and do not even know it. I am a Nicor Gas customer. Until I wrote this article, I didn’t know they were a subsidiary of Southern Company.
It’s a circular process. I pay my gas bill and some of those profits fund my quarterly Southern Company dividend!
Some of Southern Company’s major subsidiaries include:
- Alabama Power
- Atlanta Gas
- Central Valley Gas Storage
- Chattanooga Gas
- Georgia Power
- Jefferson Island Storage & Hub
- Mississippi Power
- Nicor Gas
- Pivotal LNG
- Southstar Energy Services
- Southern LINC Wireless
- Southern Power & Southern Telecom
- Virginia Natural Gas
Taken together these subsidiaries service more than 9 million customers across the territories they cover. Source: Southern Company – Service Territory
Based on customer count, the company is one of the largest regulated utility companies in America. Approximately 90% of the projected 2019 earnings come from state-regulated businesses.
All else being equal, a major appeal of regulated utilities is higher predictability and lower risk. This assumes the regulated utility has positive relationships with the state regulatory bodies in its service areas. And Southern has historically maintained excellent regulatory relationships.
In contrast to the lower risk nature of normal regulated utility operations, Southern does have some business risks to consider. Specifically, Southern has struggled with cost overruns from the construction of two new nuclear power plants (Vogtle and Kemper) over the past several years.
Because of the costs related to bringing these projects to completion, the company has had to take on significant amounts of debt in the last several years. However, based on Southern’s recent earnings presentation, they do not expect to increase debt through 2021.
SOUTHERN COMPANY DIVIDEND YIELD
The Southern stock pays an annual forward dividend of $2.48 per share. Based on the recent stock price, the Southern Company dividend payout puts the dividend yield at a very attractive 4.7%.
Let’s see what Southern Company dividend growth looks like next.
SOUTHERN COMPANY DIVIDEND GROWTH
|1 Year||3 Years||5 Years||7 Years|
Dividend growth has been low, but steady. This is exactly what you would expect from a regulated utility.
And for 2019, Southern Company management announced another 3.3% increase. This increase marks the 18th consecutive year of dividend increases.
Finally, according to the Company, “outlook supports $.08 per share annual dividend increases”. If their outlook is correct, we can expect dividend increases to slightly exceed 3% in coming years.
Let’s see what some of the business fundamentals look like next.
SOUTHERN COMPANY REVENUE TREND
Organic revenue gains come primarily from population growth and economic development in their service territories.
In addition, Southern Company and AGL Resources completed a merger in 2016. Under the merger agreement, AGL Resources became a new, wholly owned subsidiary of Southern Company. The merger added to revenue growth in 2016 and 2017.
SOUTHERN COMPANY DIVIDEND AND EARNINGS PER SHARE
Earnings have been pressured in recent years by cost overruns at the Vogtle and Kemper expansion projects. This has led to a Southern Company dividend payout ratio greater than 100% based on earnings per share.
After eliminating the future estimates to complete the Vogtle and Kemper expansions, management believes core earnings will grow 5% annually. This seems reasonable for a regulated utility.
SOUTHERN COMPANY FREE CASH FLOW
And free cash flow tells an even worse story.
As the chart above shows, free cash flow is negative. For most companies, free cash flow exceeds the dividend and the dividends are then paid from that free cash flow.
In Southern’s case, both the negative free cash flow and the dividend payments have to be financed from somewhere. And Southern Company has done this primarily by taking on additional debt. They have also sold additional shares of stock to bring in cash to fund this deficit.
This is not a great situation. So let’s take a look at Southern Company’s balance sheet and credit rating next to check their financial position.
Here is the recent trend for Southern’s debt to equity ratio.
|Debt to Equity Ratio||1.3||1.8||2.0||1.6|
The largest increase in debt was in 2016. This was partly to fund the merger with AGL. It’s good to see debt decreasing in 2018. And as previously mentioned, management believes there is no need for incremental debt through 2021.
The balance sheet is not in as bad of shape as I thought it might be. To compare, Wisconsin Energy Group’s debt to equity is 1.2 and Dominion Energy’s is also 1.6.
Southern Company has an “investment grade-moderate credit risk rating from both Moody’s and S&P. Southern’s ratings are a little lower than the typical dividend stock, but also not as bad as I thought they might be.
Let’s judge value in several ways:
- Dividend Discount Model
- Price to earnings ratio
- Morningstar fair value estimate
Dividend Discount Model
The single stage dividend discount model considers several factors I have discussed thus far.
- Current dividend payment – $2.48 per share
- Projected dividend growth – 3.1%
- My desired annual return on investment – 9%
Using these assumptions, the dividend discount model calculates the fair value at $43 per share.
Southern Stock Price to Earnings Ratio
The stock price to projected 2019 earnings sits at about 22 times. To compare, the S&P 500 forward price to earnings ratio for 2019 is 17.5 times.
Southern stock is clearly more expensive than the stock market as a whole. And Southern stock seems a little pricey for a slow growing company with a fair amount of business risk.
Morningstar Fair Value
Finally, the investment analysis firm Morningstar believes the stock is fairly valued at $52 per share.
SOUTHERN COMPANY DIVIDEND CONCLUSIONS
Southern holds a large position in my portfolio. At the time of writing it is my 8th largest holding.
It has a very substantial dividend yield, plus historically low single digit percent dividend growth. Management expects the dividend to grow at a similar rate in the near future.
Southern operates in a steady industry with predictable demand. On the other hand, they have significant operating challenges and cost overruns relative to the Vogtle and Kemper projects.
In the short run, the dividend does not appear to be at risk. However, it is one of the more risky dividend payouts of the regulated utilities covered in the dividends deluxe model portfolio. In my opinion, the stock is also overvalued at current prices.
I intend to hold my position, but monitor company performance more closely than I do with most of my dividend stocks. There is no interest on my part in adding to what is already a larger holding in my portfolio at this time.
As is usually the case with dividend growth stocks, higher dividend yields come with more risk and lower projected dividend growth. The Southern Company dividend is no exception.
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